Q: I was laid off and have had a difficult time finding a suitable job. We have lived on my part-time work and my wife’s job as a teacher. I started investigating starting my own business, and I think I have a good opportunity and a plan to succeed. My problem is raising capital. My wife and I own a home that is worth about $370,000 and it has a first mortgage of $140,000. I have avoided borrowing against my equity because I might have to use it for college costs, but I am pretty confident that I can make this business opportunity work if I can get financing. I need to borrow about $125,000 on a home equity loan. That gives me the best interest rate. My question is whether I can deduct this interest on my taxes.
A: Yes you can, because the loan proceeds will be used to fund your business. Interest expense is “traced” to the use of the loan proceeds. Money used for business purposes is allowed as business interest.
You will need to do one thing to be able to deduct all of the interest. The tax law has a special rule that treats any debt secured by a residence as “qualified residence interest.”
The interest on qualified residence debt is deductible if the loan is used to acquire, construct, or improve your residence. If the proceeds are used for some other purpose, then the interest on up to $100,000 of loan proceeds is still deductible as “home equity debt.”
There are two problems with home equity debt interest. First, the overall $100,000 limitation on the loan principal for which interest can be deducted. Your loan will exceed this limit.
Second, the interest is not deductible in computing the alternative minimum tax if the proceeds are not used to acquire, construct or improve the residence. If you are subject to the AMT for any years the loan is open, you will lose the interest deduction
The law treats any loan secured by a residence as subject to the qualified residence debt rules unless you affirmatively elect out of those rules. You want to elect out because you can get a better result with business interest.
So, for the tax year when you first obtain the loan, attach a statement to your tax return stating that you elect out of the qualified residence debt rules. You could reference Treasury Regulation Section 1.163-10T(o)(5) as the authority for this election.
Be sure to make this election. If you fail to do so, only 80 percent of the interest ($100,000/$125,000) will be deductible, and none of it will be allowed for the AMT. The election will make 100 percent of the interest deductible.
Q: I am 76 and my wife is 73, and we own our house outright and make $5,000 annual gifts to our church. Our only itemized deductions are state income taxes, property taxes and the charitable gifts. The IRS deduction for non-itemizers is $13,950 for 2017, and we won’t meet that. Is there some type of special way to deduct charitable gifts when you don’t itemize?
Unfortunately there is not. Years ago we had a limited deduction for charitable gifts made by non-itemizers, but that no longer exists.
The only way to do what you suggest is to have the gifts made directly from an IRA to the charity. This is called a “qualified charitable distribution,” and it results in the equivalent of a deduction.
I say equivalent of a deduction because you do not really deduct a QCD. Instead, you simply do not report the IRA distribution as income.
So if you have an IRA you could direct the custodian to make a $5,000 distribution payable to the church. The custodian may insist on sending you a check, but that’s fine provided the check is made payable to the church. You can then deliver the check.
The $5,000 would be excluded from your 2017 income. If you have an IRA and are taking at least $5,000 out each year, you will be able to create your own tax deduction.
This QCD strategy is the only way for you to benefit from the contribution without itemizing.
Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.